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The European Central Bank was established by the Treaty of Amsterdam in 1998 and is headquartered in Frankfurt, Germany. The objective of the bank is to maintain price stability within the euro zone. The president of the ECB is Mario Draghi, former governor of the Bank of Italy.

Business›Economy

Eyes on euro zone's firefighter

The European Central Bank is once again being seen as the body needed to solve the euro zone's new crisis, with Cyprus and Italy both in turmoil

The ECB has slashed its key interest rates throughout the crisis and sought to tame borrowing costs to worst-hit countries. Photo: AFP

The European Central Bank (ECB) will hold off from cutting rates or announcing any other policy moves at its meeting next week so as to keep up pressure on governments to solve the euro zone's crisis, analysts said.

The ECB has never hesitated to act as firefighter in the long-running crisis, which seemed to have abated until political gridlock in Italy and the crisis in Cyprus sent shockwaves through financial markets once again.

Throughout the crisis, the central bank has slashed its key interest rates, pumped more than €1 trillion (HK$9.95 trillion) into the banking system to avert a credit crunch and sought to tame borrowing costs in worst-hit countries by buying up their sovereign bonds.

The moves appeared to pay off, allowing the markets to enjoy an extended period of calm, at least until recently when elections in Italy ended in stalemate and Cyprus' parliament rejected the terms of a tough bailout deal with its international creditors.

But while all eyes will be on ECB chief Mario Draghi to calm the markets once again when he holds his regular monthly news conference on Thursday, ECB-watchers say the central bank looks likely to keep its powder dry for the time being.

"The ball remains in the court of national governments and parliaments," said Berenberg Bank economist Christian Schulz.

"The failure in Italy to form a government, but also the potentially dangerous precedents enforced by creditor countries in Cyprus are mostly to blame for the increased downside risks to the economy," he argued.

"By allowing market uncertainty for a bit longer, the ECB may raise the pressure on governments in core countries and the periphery to behave," Schulz said.

Analysts are almost unanimous that additional rate cuts are not on the cards.

The ECB has held its benchmark refi rate steady at an all-time low of 0.75 per cent since July.

"A refi rate cut cannot be ruled out entirely at Thursday's meeting. Still, we believe no more change to the key rates is likely as the governing council appears to regard a rate cut as a less effective tool," said Commerzbank economist Michael Schubert.

"First of all, in their view, the level of the key rate is not the main problem but the fact that lending rates in the periphery do not reflect the low policy rate," Schubert said.

Furthermore, the latest decline in sentiment indicators across the 17-country area "is likely to be owing to the political trends in Italy and Cyprus, and these can hardly be tackled through lower rates", the expert argued.

At the last meeting in February, Draghi conceded that a rate cut had in fact been discussed, but "the prevailing consensus was to leave rates unchanged".

Newedge Strategy analyst Annalisa Piazza predicted the ECB chief would use similar wording again this time.

"However, we suspect the current economic scenario has not deteriorated enough to convince more governing council members to support the idea of a cut," she said.

Schulz argued that a rate cut was also unlikely because it would take one of the ECB's other key rates, on its deposit facility, into negative territory, since it currently stands at zero per cent.

"This would take the ECB into uncharted territory and should thus be an emergency measure only," he said.

The deposit rate is the rate which the ECB pays out to banks for parking their money with it.

Pushing the deposit rate into negative territory is potentially risky because while it could spur banks to lend money rather than paying a penalty to the ECB, it would also reduce profitability and force banks to raise lending rates they charge customers to make up the difference.

Commerzbank's Schubert pointed out that both Draghi and other governing council members have suggested that a negative deposit rate could bring with it "severe consequences".

"In a nutshell, we don't expect any changes in policy," said Piazza at Newedge Strategy.

"A sudden move would be seen as a sign of panic" and would only serve to erode confidence still further, she said.

But UniCredit analysts, in a weekly investors note, said it would nevertheless remain "up to the ECB rhetoric to calm the nervousness".

This article appeared in the South China Morning Post print edition as Eyes on euro zone's firefighter